Contingent consideration is a type of payment that is dependent on the occurrence of a future event. In accounting, contingent consideration is recognized and measured when it is probable that the event will occur and the amount of the payment can be reasonably estimated.
According to International Financial Reporting Standard 3 (IFRS 3), “Business Combinations,” contingent consideration is recognized as a liability in the acquirer’s balance sheet at the acquisition date. The liability is measured at fair value, which is the best estimate of the amount of the future payment at the acquisition date.
The fair value of contingent consideration is determined using a valuation technique, such as a discounted cash flow analysis or a probability-weighted expected return calculation. The fair value of the liability is then adjusted for the passage of time and changes in the probability of the event occurring, until the event is no longer probable or the amount of the payment can no longer be reasonably estimated.
Once the event has occurred and the amount of the payment has been determined, the acquirer is required to remeasure the liability at the amount of the payment. The difference between the original measurement of the liability and the remeasurement of the liability is recognized in the acquirer’s income statement as a gain or loss on the contingent consideration.
For example, if a company acquires another company and agrees to pay a contingent consideration of £1 million if the acquired company achieves certain financial targets, the company would recognize a liability of £1 million at the acquisition date, measured at fair value. If the acquired company achieves the financial targets and the amount of the payment is determined to be £1 million, the company would remeasure the liability at £1 million and recognize any difference between the original measurement and the remeasurement as a gain or loss on the contingent consideration.
